Historically, retirement security was considered the responsibility of the employer or government. Defined benefit retirement plans were established providing employees a certain defined monthly benefit during retirement. Due to the number of variables involved and the extensive period of time covered before and during retirement, the cost of these plans became burdensome and costly to employers. As a result, employers have increasingly shifted since the advent of Internal Revenue Code Section 401(k) and similar retirement plans in 1981 to defined contribution plans. With the majority of defined contribution plans, it is the responsibility of the employee to electively save a portion of his or her annual salary. Some employers match or partially match the employee's contribution.
The shift from defined benefit to defined contribution has caused an enormous shift in the level of individual responsibility for retirement savings and investment decisions. Previously, all such matters were transparent to the participant. Now the individual has to both determine an adequate contribution and investment choice. Further, participants have the option of borrowing from the defined contribution account within certain regulatory limits.
The typical actuarial calculations for a defined benefit plan are performed using sophisticated computer models created by actuaries with years of training and experience. Complex calculations with numerous variables are necessary to determine an estimate of adequate employer contributions to meet retirement security requirements. Now participants are left to their own devices to determine the adequacy of contributions. Although the average participant has no such ability, this situation has persisted for over 15 years. The Department of Labor has recognized that there is a problem and is now issuing new guidelines calling for increased employer instruction and direction on retirement planning and investment choices.
Employers have also recognized that many employees are not saving sufficiently for retirement and/or are not investing appropriately to allow sufficiently high rates of return to allow contributions to grow to adequate levels. It is this recognition that partly causes many employers to discourage any form of borrowing from retirement assets. Nevertheless, most employers recognize that the availability of pension based loans increase contributions and numbers of participants. There is, however, a serious concern that large numbers of younger employees are not saving adequately for their retirement. With the acknowledged underfunding of Social Security and the expected demographic shift in the U.S. population, the ongoing national crisis is only expected to deepen.
The present invention seeks to solve these systemic problems that have existed for over a decade and a half by designing a system that properly supports an individual participant in making the correct retirement decisions without the construction of artificial liquidity barriers and restrictions imposed on all plan participants. There has been a long unaddressed need for a financial planning method and system that communicates with simplicity to the individual the effect of pension-based decisions on retirement security before, during, and after a liquidity or contribution decision is made.
Once an individual is provided adequate information to make informed retirement planning choices, there arises a need for a process and system that will allow each individual to customize and optimize their retirement choices efficiently. This will allow retirement planning to be closely aligned and optimized with non-retirement financial planning. For example, there have been several recent efforts to reduce personal interest costs by securing personal debt against assets, including U.S. Pat. No. 5,206,803 entitled "SYSTEM FOR ENHANCED MANAGEMENT OF PENSION-BACKED CREDIT." Such efforts seek to allow individuals to reduce the cost of current consumption, borrowing and related interest by utilizing the benefits of secure assets. However, such efforts fail to provide the necessary information required to allow the individual to knowledgeably monitor and control the outcome to result in improved retirement security.
The following problems continue to go unaddressed despite the efforts of the prior art to reduce interest costs through a line of credit secured against pension-based assets:
(1) Individuals need to reduce the costs of personal short term credit from rates that frequently exceed 20%, and if so, may more readily save for retirement with the increase in disposable income. Pension-based loans, generally at rates of prime plus 1%, have appeared attractive when compared to credit card debt which averages over 17%. However, pension-based loans as currently offered cause long term assets to be liquidated that would have potentially earned higher rates of return if left intact. Other efforts to solve the problem of high interest costs fail in their stated objective when the interest cost paid to the pension account is added to both the administrative cost and the opportunity cost associated with liquidated long term investments. PA1 (2) Individuals need increased mechanisms for pension-based liquidity to optimize individual financial plans and increase contribution rates. Restrictions on pension-based loans reduce contributions as limited resources must be saved outside of the pension plan account for expected requirements prior to retirement. However, with improved access or liquidity, contributions may be optimized maximizing the tax deferral captured each year. The optimizing of retirement contributions would increase retirement security for many individuals whose current retirement savings are inadequate. PA1 (3) Individuals need timely and understandable retirement planning information to make effective retirement related decisions. Plan sponsors and financial planners remain concerned about the impact of pension-based loans on retirement security. The concern relates to uncertainty as to whether the individual is using retirement assets for current consumption. Further, the uncertainty is a function of multiple unknown variables to the parties involved, including the adequacy of retirement contributions relative to retirements needs and age, the adequacy of rates of return on investment choices, and other individual specific factors. Not only do the plan administrators lack this information, the individual making the liquidity decision lacks much of the necessary information to make an informed decision. PA1 (4) Employers need to have confidence that individuals have access to timely and understandable retirement planning information to fulfill fiduciary duties and thus have confidence in eliminating artificial restrictions to pension-based liquidity. Employers have eliminated financial responsibility for adequate retirement benefits and therefore have eliminated the calculations previously performed. However, this has left the individual with the responsibility for adequate contributions and investment decisions without the ability to perform the necessary calculations to determine adequacy. This problem affects both contribution and liquidity decisions. PA1 (5) Employers need increased pension-based liquidity to increase the pension matching contribution portion of total compensation. Both employers and individuals would be better served, through reduced costs and improved asset growth, by increasing matching contributions to be more closely aligned with actuarially determined requirements. However, employers have been limited by the liquidity needs of a portion of their employee base as matching rates must be applied consistently across the employee population. Increased liquidity mechanisms could solve the problem posed by the higher liquidity needs of a portion of the employee base that needs access in the short-term to a greater portion of their compensation. PA1 (6) Individuals need to be protected from pension-based loans becoming taxable distributions due to lack of loan portability. Many plans require pension-based loans to be repaid within a short period after termination. This frequently is not possible. In today's economy when numerous job changes are expected throughout a career, such artificially triggered taxable distributions may have a substantial detrimental effect on retirement security. PA1 (7) Individuals need to have access to relatively short-term pension-based loans without liquidating long term investments. Liquidating long-term pension assets potentially reduces retirement security. A traditional 401(k) loan liquidates long term investments in the plan and disburses the proceeds directly to the participant in exchange for a promissory note from the participant. Repayments of interest and principal on the promissory note are credited to the participant's retirement account. However, with the growth in retirement based borrowing (conservatively estimated at $16 billion in 1995), long term retirement assets have increasingly been liquidated to fund participant's relatively short term credit needs. The liquidated assets have been replaced with relatively low yielding promissory notes. As a result, in 1995 when the S&P gained over 35%, those participants having borrowed from their assets received generally prime plus 1% (9.25%), an opportunity cost of over 20% in one year. Over the past 50 years the S&P has performed at an average of 11.8% per annum, substantially greater than prime plus 1%. Actuaries can readily demonstrate that this difference in expected return on retirement assets causes a substantial change in retirement security over time. All current pension-based loans have this effect on retirement security during a period when many do not have adequate retirement savings. PA1 (8) Pension-based liquidity resulting from loans is currently costly, another restrictive barrier. Today, virtually all disbursements of plan loans are made by check. The leading practice in the retirement industry currently requires 12 days to process and disburse a plan loan, but only after the participant has prepared a written loan application. PA1 (9) Retirees need to have electronic access to retirement assets for ongoing retirement spending. Current disbursement methods remain relatively unchanged from those used over twenty years ago when ERISA was adopted. Retirees would be better served by leaving assets at work in the pension plan until needed for retirement based spending.
The process and system of the present invention addresses each of the above problems utilizing a combination of existing elements and newly created elements to better serve the retirement saver. The present invention is a significant improvement over the prior art that has attempted to address some elements of the problems discussed above.
Efforts have been made to link into traditionally inaccessible lines of credit as a means to reduce consumer credit costs. This includes the approach adopted in U.S. Pat. No. 4,718,009 entitled "DEFAULT PROOF CREDIT CARD METHOD SYSTEM." This system applies credit using the cash value associated with a life insurance policy as collateral to support periodic credit needs of the policy holder. Although the system permits a flexible line of credit, the act of borrowing still is carried on in a conventional sense with a bank and/or institution, and the underlying resource is poorly utilized, thereby limiting the available savings to the consumer.
The approach adopted in U.S. Pat. No. 5,206,803 initially may appear to provide a mechanism to reduce interest costs compared to average unsecured credit cards. This system, however, still allows and in fact encourages (1) long term investments to be liquidated to provide short term credit or liquid security for short term credit, (2) credit card charges to go directly against pension assets causing retirement borrowing to be as common as putting gas in one's car, and (3) actual borrowing costs to equal or exceed the average cost of an unsecured credit card. The latter point indicates that this system will fail to achieve its desired function. After considering the opportunity cost of moving assets from average returns of 11.8% to returns as low as 6% or below in a money market fund, as well as administration costs of 3 to 4% plus additional annual fees, the participant has paid at least 9 to 10% in costs for his use of his own funds. This is over and above the prime or 8.25% paid to his own retirement account, a total effective rate of 17.25 to 18.25% per annum for the use of those borrowed dollars. This range is equal or greater than average unsecured credit card debt, causing the system to fail its stated objective to provide a low cost line of secure credit. The system disclosed in the '803 patent secures credit cards directly against pension assets in the form of a line of credit. Interest costs, when applying historical data to this system, are not properly reduced. Further, trivial spending may be charged incessantly to the card with no safeguards other than regulatory limits. Further the increased liquidity is not safeguarded by personalized retirement planning information, causing this system to compound the risks affecting retirement security.
In addition, prior art systems make no attempt to address the most substantial opportunity cost related to their proposed solutions. Prior art systems have not addressed the implications of reducing retirement security by increasing pension-based liquidity without providing the necessary information to the individuals to make informed retirement planning decisions.
As a result, there remains a long standing unaddressed need for a pension liquidity system that, while delivering on the promise of reduced interest costs, does not lose sight of retirement security. Retirement security may be enhanced if the problems of liquidity limitations, liquidity costs, individual choice, individual retirement plan optimization, informed retirement decisions, loan portability, and asset disbursement costs are adequately addressed in a pension planning and liquidity management system.